China premier Li Keqiang insists economy ‘within appropriate range’

30 Aug 2015 | Author: | No comments yet »

China’s economic judders bring questions – and opportunity.

NEW YORK – After a dizzying two weeks that saw a rapid plunge and rebound in equity prices, investors are looking forward to a week of economic data that may provide clarity on the likelihood of a near-term U.S. interest rate hike and help tamp down the market’s recent wild swings.Oxford Economics said the disinflationary forces generated by a big downturn in the world’s second largest economy would keep inflation below the Bank’s 2pc target well into 2018.The collapse in Chinese markets has brought into focus a question that Western nations have been grappling with since the 2008 financial crisis: how much, if anything, stock markets have to do with the real economy.

Its forecasts showed that, while a moderate slowdown was unlikely to hit Britain’s recovery, if growth in China slowed to an average of 4pc until 2020, from about 7pc over the past few years, the UK economy would grow by just 2pc next year, against a baseline assumption of 2.8pc. Warning signs that Chinese stocks were overheating have been clear for months, and the scenes of distraught retail investors losing their life savings as prices began to snap back in June barely made a ripple in global markets, until last week.

Car sales, construction spending, the Federal Reserve’s “beige book” and jobs growth may show the economy is strong enough to withstand the first rate hike in nearly a decade from the Federal Reserve, despite worries about a hard landing for China’s economy. Inflation, as measured by the consumer prices index, would average just 0.9pc in 2016 and 1.3pc in 2017, according to Oxford Economics, against assumptions of 1.7pc and 1.8pc. The Shanghai and Shenzhen brokerages were viewed as one step above casinos, with 80pc of the daily trading volumes coming from ordinary retail investors allowed to leverage up to the hilt on a state-sponsored bull run. Global stock markets were stung by severe swings in recent weeks, stoked by concerns that a slowdown in China’s economy may be more harsh than anticipated.

Its simulations suggest that Bank policymakers would be spurred to cut the base rate by 0.25 percentage points under this scenario to a new low of 0.25pc. Peter Fitzgerald, Aviva Investors’ head of multi-assets investments, said: “There’s a big difference between the Chinese economy and the Chinese stock market. But after confirming a move into correction territory, the S&P 500 rebounded to score its best two-day percentage gain in over six years last week, as comments from Fed officials led some investors to believe the market turmoil and global growth concerns had diminished the possibility of a rate increase at the central bank’s September meeting. In the last 25 years, the Shanghai Composite, China’s benchmark stock index, has closed within one percentage point of the previous day’s close on just 56% of all trading days, with an average movement of 0.09% (see chart).

Fed Vice President Stanley Fischer told CNBC during the Fed’s annual conference in Jackson Hole, Wyo., that the committee was “heading in the direction” of higher rates. Indeed, given our expectation that a world of weak Chinese growth would see UK inflation running at less than 1pc in 2016, the Bank may well be compelled to cut interest rates to try and offset disinflationary forces emanating from the East. Some City insiders have pointed to Beijing’s decision to devalue the yuan on August 11 as a warning that China’s economy was indeed slowing; others suggested disappointing data on manufacturing growth a week later was the trigger. Traders in futures markets that bet on rate increases then boosted September’s odds. “There is a narrative out there that Yellen’s Fed is looking for a reason to delay the rate hike; I don’t think that is necessarily the case,” said Brad McMillan, chief investment officer for Commonwealth Financial in Waltham, Mass. Others still have said it was the People’s Bank of China’s failure to intervene to prop up the market over the weekend of August 22-23, as it had done during previous wobbles, that finally unnerved traders.

Mr Beck said the stock market tremors alone were unlikely to dent consumer confidence: “UK households’ direct equity holdings are fairly small, suggesting that the effect of the drop in the FTSE 100 on household spending will be limited. Policymakers in China are trying to shift the balance of growth towards domestic consumption and away from fixed investment in order to foster more sustainable growth.

The PBOC was throwing “everything but the kitchen sink” at the crisis, with interventions in both equities and currencies, according to Andrew Polk, senior economist at The Conference Board, as the central bank seemingly tried to get out in front of the expectations of increasingly frazzled markets. Judging by the market’s historic volatility, the 8.5% sell-off on Monday was indeed an extreme anomaly, with the daily return falling more than three standard deviations away from the average—a so-called “three sigma” event.

The New York Stock Exchange used its circuit breakers, installed after the 1989 crash, to pause stocks on 1,278 occasions on what was immediately dubbed Black Monday. Indeed, the FTSE 100’s 4.7% drop on Monday, at 4.2 standard deviations from its average return, was a bigger outlier (about 1 in 10,000) than China’s market decline, at 3.2 standard deviations (5 in 10,000). While there’s a history of authorities intervening in the markets, it’s tended to happen when values are very low and it was needed to support confidence.

It’s created considerable mistrust for foreign investors.” There is a stark contrast between the PBOC and the US Federal Reserve’s approach to managing markets. American central bankers have been signalling for two years that the crisis-era programme of vacuuming up bonds from the market, known as quantitative easing, would be wound up as the economy improved. Even this approach wasn’t enough to prevent the “taper tantrum” of 2013, when the markets took umbrage at the suggestion that the Fed would begin to tighten monetary policy. China’s abrupt interventions have therefore come as a surprise to investors who have only recently gained direct access to the country’s A-share market. The more optimistic watchers point out that the US markets have just been through the third-longest period in the past 90 years without a major market fall of at least 10pc.

Some also sound a note of caution about the timing of the rout, during what is normally the height of the summer slowdown on trading floors around the world. Nigel Brahams, a partner in financial services and markets at the law firm Fox Williams, said: “High-frequency trading doesn’t ultimately change the direction of the market but it accelerates and exaggerates it.

However, UBS also has deeper concerns about China’s health. “We take the sell-off very seriously, as this unfamiliar mix of emerging market uncertainty, deflationary pressure, central bank interference, and extreme volatility is hard for global markets to digest,” he said. UBS has crunched the numbers on a possible Chinese slowdown and has estimated that a 1pc drop in economic growth would knock up to 0.4pc from Europe’s output. Even though China buys relatively little from European trading partners, equating to about 3.1pc of overall exports, a slowing consumption of fuel, commodities and consumer goods might spiral into deflation further afield. On Tuesday the European Central Bank’s vice-president, Vitor Constancio, tried to dampen anxiety over an economic slowdown in China, saying that the economy did not show signs of major deceleration and that Europe’s central bank stood ready to intervene if deflation reared its head.

But without the central banking might of Beijing, or its $3.65 trillion capital reserves, they are consigned to wait for signs of progress from within China. The annual Jackson Hole get-together this weekend has allowed the US authorities to drop more hints about what the China shudders might mean, with every morsel on inflation and interest rates carefully watched. The Communist government’s next five-year plan will be aired in October, with Premier Wen Jiabao’s desire to move more people into urban centres likely to continue unabated. Signs of interruption in the long-term goal to rebalance the economy from manufacturing to services would hinder Beijing’s other goal of further opening up its economy to the world.

However, Ms Yeung added, “you can’t lose sight of the fact that China needs to deleverage and the reform agenda still needs to be implemented.” Stock-pickers within the City investment firms Aviva, Aberdeen, Fidelity, Numis and St James’s Place were among those who bought into the declines during last week’s dizzying trading sessions. The PMI reading fell to 49.6, below the 50 mark that separates growth from decline, as market-watchers fret that property and industrial output have hit a wall.

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